Peyto Exploration & Dev. PEYUF W
May 12, 2003 - 11:01am EST by
2003 2004
Price: 10.71 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 466 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Peyto Expl. & Dev. (PEY, Cdn/PEXDF, US)

For members who may have missed out on Search Energy/Advantage, I’d like to submit another exceptional E&P that is converting to a Unit Trust structure. The company is Peyto Exploration and Development (PEY in Canada; PEXDF in US). Peyto has been a wildly successful E&P, and, I believe will be a new paradigm for Oil and Gas Unit Trusts too. PEY has been one of N. America’s fastest-growing NG producers; It is extremely efficient and highly profitable. As opposed to many unit trusts with high depletion rates, PEY’s NG comes from deep, long life Cardium wells in the Sundance region of Alberta. Cardium wells have two very attractive attributes: The gas produced is rich in liquids so it fetches a price premium to AECO. More importantly, these wells have very low production decline rates, some in the 4-5% range.

If you go to Peyto’s website,, you can see that PEY has had phenomenal growth in reserves and production. Some highlights:

-YOY production up 111%, 203%, and 1024% for 2002, 2001, and 2000, respectively.
-long life reserves-16.5 years established, 10.5 proven & probable
-low cost structure-operating costs of $1.36 per boe and total costs of $2.67per boe for 2002.
-low finding and development costs-p&p reserves $5.06/boe of 2002 and $5.19/boe since inception
-high proven producing recycle ratio-3.8 for 2002, 4.0 since inception
-organic growth-growth thru the drillbit not the checkbook or secondary offering
-insider ownership. Is currently 21%, will go up to 24%.
-no management fee
-internalization of exploration and development drilling.

It is the last point, and the fact that PEY will likely pay out only a little more than 50% of cash flow (as opposed to 80-90% industry standard) as dividend that is both the source of confusion and value here. PEY was recently generating C31cts/mo. in cash flow; I think they will likely pay out 17cts/mo in dividend, to yield around 14%. AVN, the premiere gas trust, in my opinion, yields 17.5%, paying 23cts/mo. on likely cash flow of 35cts/mo with NG up here. The difference will be that PEY will continue to grow reserves and production PER UNIT at a very high pace (likely 15-20% per annum). AVN has done a phenomenal job of increasing reserves and production per unit by single digit percentages annually. The beauty of both these trusts is that they will be growing value while yielding mid/upper-teens. Most trusts are declining assets, so a portion of your “yield” is in reality a return of capital. If PEY can achieve what I believe it can, the dividend will continue to grow as production per unit grows, all while the underlying reserves are increased. Since the unit trust market is fairly immature and inefficient, I think it is still in the process of differentiating unit trusts that have the assets, management, and future, from those that are more like buying a 5-year note at a massive premium. PEY will join AVN as being one of those that will be rewarded for providing both yield and value-creation.

PS: Members may recall that I have made the bullish case for NG in the past. Although NG has had a nice rally in the interim, I am still bullish near and long term on NG, albeit with likely high volatility. The value in PEY is not predicated on increasing NG prices, but would be a marvelous tailwind if it occurs as I expect. I would be happy to elaborate further on the NG situation as I see it.

PPS: Ya gotta love a stock that's name after "Wild Bill Peyto"......


1)Conversion to Unit Trust structure has created some confusion regarding valuation. E&P investors/takeover speculators have been selling. Unit trust buyers will emerge as conversion date approaches/happens. Additionally, PEY, the Unit Trust, will be in various trust indices, and trusts-of-trusts, precipitating buyers.

2) A maturing trust market will differentiate true value-enhancing, true-yield trusts like AVN and PEY from the other depleting-asset trusts, benefitting the former at the latters' expense.
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